Re-elect Incumbents Act

This post explains the likely inflationary result of the recent stimulus package passed by Congress.

(Notice the dramatic increase in US money supply in recent months.)

(The above Chart shows the recent jump in the CPI)

(This Chart shows the even more dramatic recent jump in the PPI)

You hit a nerve with this one. I really think that this should be called the "Re-elect Incumbents Act of 2008." It is really about putting money in people's pockets shortly before the election in hopes that people will be happy about it and re-elect those in office. Here is how it will work.

1. Since we are already running a deficit, the Treasury Department will have to borrow more money to make these payments. Thus, Treasury will sell government bonds in the market, mostly to big banks in New York.

2. They will take that money and send it out to people who qualify for the payment.

3. Since the Federal Reserve is also trying to use monetary policy to stimulate the economy, the Federal Reserve Bank of NY will call up the big banks in NY and offer to buy government bonds from them (remember they just purchased such bonds from Treasury). The banks will sell the bonds to the Fed, which will deposit money in the banks accounts with the Fed.

4. The Fed is legally able to create money. Thus, the deposits are new money into the US money supply.

5. This additional injection of money into the money supply, when the money supply has already been rapidly expanding and inflation is already running at its highest rate in the last 2 decades, will likely result mostly in additional inflation, rather than stimulating the real economy.

6. Such actions by the government normally have a lag time before inflation kicks in. Thus, the resulting inflation is likely to be apparent after the November election.

7. It the government really wanted to stimulate the economy, they would focus on policies which would increase investment or even on improving public infrastructure. In other words, I prefer policies that would encourage people to produce more. Stimulus policies that focus on increasing aggregate demand, without increasing aggregate supply, tend to be like crack cocaine. You get the feeling of a big rush up front, but the long-term effects are harmful.